Crossing the VC Rubicon - Ten questions for your perspective VC investor — II

With all the recent excitement about instant riches that the IT
industry appears to hold lately, entrepreneurial activity in the sector
seems to have increased dramatically. At the same time, Venture Capital
(VC) investors must be feeling encouraged by the success of some of the
earlier investments, now generating handsome returns. The positive outcome
of all this excitement is the numerous investments that have been reported
in the past twelve months or so. In the days to come, one could expect
many more such entrepreneurs to seek out VCs and VCs to go after promising
IT companies.

In a four-part series, the author sets out some of the points that
entrepreneurs aspiring to raise VC may find helpful to bear in mind.

What is the VC's source of funds? How deep are their pockets?

Let me warn you, not many VCs will take very kindly to this question.
After all, they are the one with the money. And you would not have been
talking to them if they did not have the funds. Right? Well, not
necessarily.

There was a time in our market, not long ago, when eager twenty-somethings,
who had raised public fixed deposits, (due for repayment at the end of two
years, or some times even on call) aspired to make long term (three year
plus) investments. What happens to you if as an entrepreneur you raise
money from one of them? The investor will be baying to have you "buy
back" his shares in less than two years if he cannot force you to do
a public offering, for no fault of yours. So, you as entrepreneur, have
the right to ensure that the VC fund has back-to-back long term funding.

This is yet another common situation. Many a time an investor will be
happy to give you the first Rs 50 lakhs that you badly need. But come next
round, eighteen months down the line, he does not have the Rs 3 crore that
you need to go to that next level of growth. Or his institution's
"investment policies" do not allow him to "take further
exposure in your company". Nor does he have the credibility to get
someone else to provide you the Rs 3 crore you need. But should that
bother you? My answer is, yes. Because when you go to another investor
without the backing of a credible existing investor, it is going be fresh
ground breaking all over again. And when you are done with your first
round of fund raising, I am quite confident that you will not quite look
forward to this round of experience all over again.

More related questions:

Does the VC fund have money in the bank? Or, is he still raising his
fund?

I have been associated with an instance where a foreign fund, which
went on to become a successful IT industry investor in India eventually,
that did not have funds in place to 'write the cheque' for an investment
after months of intense negotiation and due diligence.

How old is the fund?

Most funds have a limited life of seven to ten years at the end of
which they have to sell their investments and return the money to the
people they raised it from. If you are raising money in the fourth year of
a seven year fund you know that you will be on the fund's desperate list
for exit through a public offering or sale, like it or not, within two
years of raising the money.

Does the fund have the flexibility to provide capital outside of India
too?

The IT industry in India is one of the most outward looking, with
increasing need for capital to create a meaningful international presence.
Many funds have recognised the need for this and are preparing themselves
to invest simultaneously in India and outside.

What are the steps in the investment process? What are the deliverables
at each stage? How long does it take to get the cheque out?

The most commonly asked question from my several years of experience.
As a matter of fact, I include it in my list of questions just for the
sake of completeness and good order. But rarely does this question elicit
meaningful, even if honest, answers.

The caveat here is that these days, many funds seem to come up with a
term sheet, fairly early on in the investment process. (The term sheet,
for the uninitiated in VC mobilisation, is a very reassuring piece of
paper. It almost sounds like an offer on the table, with all the price and
non-price terms laid out in meticulous detail. But read carefully and you
will find and obscure proviso that the offer is "subject to due
diligence".

Questions you most certainly want to ask in this regard are:

How long does it take from the term sheet to the cheque? And what
specifically does it take to get to the cheque?

More importantly, what are the chances that the terms of offer will
vary significantly from the term sheet?

Again, chances are you will not get honest answers. But do go ahead and
ask them nevertheless. What do you have to lose after all?

Does the chemistry match?

At the end of the day, the quality of your relationship with the VC is
a function of interpersonal chemistry. It is important therefore that both
you as entrepreneur and the VC manager are convinced that you can work
together. Remember, as in all commercial relationships, contracts and
lawyers are brought in only when the relationship is in trouble. It is
worthwhile making sure upfront that there is a reasonable chance that you
will not need the contracts or lawyers to manage your relationship with
the VC.

Does the VC fund have an international connection?

I suggest this question at the risk of appearing to be pushing an
agenda. But look at it this way. The IT industry has been, and will,
continue to derive a bulk of its revenue from outside of India,
especially, the western hemisphere. A VC fund which is part of a reputed
international network can definitely help in developing a market for the
investee's product, services and technologies. It can help develop
powerful international strategic partnerships. It can be helpful in other
ways too. For eg, there are business models of successful software
companies in that part of the world which the VC can bring home to its
Indian investee. Not to forget the organisational and financial
engineering inputs that they bring to the increasingly popular Nasdaq
listing, the star that seems to there in every Indian IT entrepreneur's
eye these days.

What is the VC fund's track record?

Competitive experience, here and elsewhere in the world, has taught
most VCs worth a mention that if a prospective investee is worth their
attention he (the investee) will probably deem it fit to ask all these ten
questions. And so they have glitzy brochures that more or less pre-empt
these questions. How empathetic indeed!

The trick though, is to find out how close the VC's performance has
been to promises on those glossy brochures. Try asking the investee
companies in their portfolio. Better still, find out if you can about
those unsuccessful ones that have not been listed in the brochure and ask
those "failed" entrepreneurs to balance out the paeans of the VC
investor that the successful ones (showcased in the VC's brochure) will
undoubtedly sing.

These brief observations, I hope, will help you get thinking about the
issue of raising VC more comprehensively. Hopefully, through this column,
in the days to come I will get to share, Insha Allah, some of my thoughts
and experience on some specific aspects in slightly greater detail.

In the meantime, happy VC fund raising for those who have set in motion
the process of VC equity raising already.